EU’s great turnaround reform

Author: | Published: 25 Apr 2017

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Mihaela Carpus-Carcea, legislative officer in
the Directorate-General for Justice and Consumers, presents the
European Commission’s three-pronged proposal to
boost the efficiency of insolvency procedures

On November 22 2016, the European Commission (EC)
submitted to the Council of the EU and the European Parliament
a proposal (COM(2016) 723 final) on harmonising key aspects
relating to preventive restructuring procedures, second chance
for entrepreneurs and measures to increase the efficiency of
insolvency proceedings. The proposal is a follow-up to an EC
recommendation of March 12 2014 for a new approach to business
failure and insolvency, which has been implemented to some
extent by several member states. The project of harmonising key
insolvency aspects has received further impetus in the context
of the EC's priority initiatives on a Capital Markets Union and
the Single Market Strategy.

The 2015 Capital Markets Union Action Plan (COM (2015) 468
final) announced a legislative initiative on business
insolvency, including early restructuring and second chance.
This initiative was intended to address the main barriers to
the free flow of capital and build on national regimes that
work well. Aligning the procedures available to parties to
restructure a debtor's business before it becomes insolvent
will bring more legal certainty to cross-border investors.
Making all insolvency procedures more efficient and therefore
less lengthy will also lead to higher recovery rates for
creditors. These measures are likely to make the EU a more
attractive place for investors.

The Single Market Strategy (COM(2015) 550 final) also stated
that the EC would support honest entrepreneurs and propose
legislation to ensure that member states provide a regulatory
environment that is able to accommodate failure without
dissuading entrepreneurs. The European Single Market needs to
encourage entrepreneurship and innovation and this cannot be
done unless there is a change in attitude about failure.

The Economic and Financial Affairs Council (Ecofin)'s
conclusions of July 2016 for a roadmap to complete the Banking
Union underlined the importance of the work on minimum
harmonisation in insolvency law to support efforts to reduce
future levels of non-performing loans, improve the management
of non-performing loans in member states and increase the
resilience of member states' economies to economic shocks.

What does the proposal cover

The proposal has three main parts: minimum standards on
preventive restructuring procedures, minimum standards on
second chance for entrepreneurs and certain measures to
increase the efficiency of insolvency procedures in general.
Mindful of the richness of the legal traditions in Europe, the
proposal gives member states sufficient flexibility to
implement the principles and rules laid down in the proposal.
Member states may, among other things, choose to put in place a
brand new pre-insolvency restructuring procedure or to improve
existing procedures. Importantly, the proposal ensures that any
national preventive procedure could be recognised in other
member states of the EU.

Preventive restructuring procedures

Currently, every year in the EU, 200,000 firms go bankrupt.
This means 600 companies every day. Half of all companies in
Europe do not survive past their first five years of existence.
About one in four insolvency cases are cross-border
insolvencies. But the insolvency of one company, even when
purely domestic, can have domino effects along the supply
chain: one in six insolvencies is a knock-on effect of a
previous insolvency.

In most member states, the most likely outcome for companies
in financial difficulties is still a liquidation procedure
rather than a restructuring. Small and medium-sized enterprises
(SMEs) are particularly vulnerable due to high costs of
restructuring, but these SMEs account for 99% of all EU
companies. The prevalence of liquidation procedures has an
impact on the average recovery rates for creditors: data shows
that the highest recovery rates for creditors are in economies
where restructuring is the most common insolvency proceeding:
83 cents on the dollar, versus 57 cents on the dollar in
countries where liquidation is the prevalent outcome.

As a result of the failure of these companies, over 1.7
million people lose their jobs each year. These people have to
look for new jobs and face uncertainty for their futures.

The proposal will increase the opportunities for viable
businesses in financial difficulties to be saved rather than
liquidated while at the same time ensuring a balance between
the rights of debtors and creditors, with due regard to the
interests of other stakeholders as well.

The proposal will give debtors access to early warning
tools to detect a deteriorating development of their
business

The proposal will give debtors access to early warning tools
to detect a deteriorating development of their business. It
will give companies in financial difficulty, wherever they are
located in the EU, the chance to restructure at an early stage,
and thus avoid insolvency when the company immediately loses
value.

The debtor will remain in control of its assets and affairs
to ensure a minimum disruption of the operation of the
business. Appropriate supervision by an insolvency practitioner
can be put in place in complex cases or where certain measures
might affect the entire body of creditors (such as a general
stay of enforcement).

The debtor can benefit from a court-ordered, temporary stay
of enforcement actions (a breathing space) to facilitate
negotiations with creditors and successful restructuring. The
stay should not be in principle longer than four months, but
member states could provide that it is extended if necessary to
ensure the success of restructuring negotiations, in particular
in more complex cases involving larger companies. Specific
rules provide for the protection of employees' claims during
the stay period.

To ensure that creditors' rights are properly reflected in
the adoption of restructuring plans, for the purposes of voting
on a restructuring plan they shall be treated in different
classes reflecting their different interests. As a minimum,
secured creditors should vote separately from unsecured
creditors.

A court confirmation of the restructuring plan agreed by
creditors will be necessary in certain well-defined
circumstances, where there are dissenting creditors or where
the plan provides for new financing.

The proposal also facilitates new financing and interim
financing, in that it guarantees a minimum protection from
avoidance actions in subsequent insolvency procedures. Member
states may go further should they wish to further compensate
the risk undertaken by such creditors and give new financing
super-priority status.

Shareholders will not be allowed to obstruct unreasonably
the adoption of restructuring plans that are able to restore
the viability of the business.

Several of the provisions have been designed with a focus on
reducing cost and complexity and providing incentives to
address financial difficulties early for SMEs as debtors, while
others aim at improving the protection of SMEs as creditors in
the supply chain.

Second chance for entrepreneurs

Once an entrepreneur goes bankrupt and irrespective of
whether he/she has been acting in good faith, the possibilities
to discharge debt and have a fresh start are still limited,
despite reforms in this area undertaken by several member
states in the past few years. The lack of a strong second
chance culture for entrepreneurs has an impact on
entrepreneurship and innovation: almost half of all potential
European entrepreneurs say they are held back by the fear of
going bankrupt and its consequences.

In May 2011, member states committed to reduce discharge
periods for entrepreneurs to a maximum of three years by 2013.
Yet today it is still very hard or impossible for entrepreneurs
to have an early restart after a first failure. In some member
states discharge periods are much longer, while in others the
conditions for obtaining it are prohibitive.

The proposal will put in place a limitation of the discharge
period for honest, over-indebted entrepreneurs to a maximum of
three years. Many honest entrepreneurs caught in debt traps
could thus return to the productive economy. Member states are
free to maintain or introduce stricter conditions to discourage
bad faith, fraud and abusive applications. This measure is
expected to lead to up to three million new jobs.

Member states may also decide to extend the second chance
provisions to consumers, depending on their national
circumstances.

Increasing the efficiency of insolvency procedures

Having efficient insolvency procedures is key to ensuring a
swifter handling of such cases and increasing the overall
recovery rates and the residual value of potential
non-performing loans.

The low recovery rates are, in no small part, due to the
length and inefficiency of procedures especially in some member
states: in 10 member states it takes creditors more than two
years (and up to four) to recover a claim in insolvency.
Lengthy, inefficient and costly insolvency proceedings in some
member states were found to be a contributing factor to
insufficient post-crisis debt deleveraging in the private
sector and to exacerbate debt overhang. But procedures could be
shortened and made more efficient, and thus limit the loss of
value for all stakeholders involved. The proposal contains
several measures to that effect.

In 10 member states it takes creditors more than two
years (and up to four) to recover a claim in
insolvency

First, it is proposed to improve the training and
specialisation of the judiciary and administrative authorities,
to ensure that they are able to make complex decisions with
potentially significant economic and social repercussions in
the shortest period possible.

Second, improvements are proposed as regards the
transparency of the rules on appointment, supervision and
remuneration of insolvency practitioners, and thus contributing
to mutual trust between courts and insolvency practitioners in
different member states.

Finally, the introduction of distance means of communication
in court procedures will help shorten the length of procedures,
but will also further involve smaller and cross-border
creditors for whom the disproportionate costs of pursuing their
claims means that often they abandon such claims.

It is also important to collect reliable and comparable data
on multiple procedures, their outcome, length and costs to
assess how member states are implementing the directive and how
well their systems are performing. The proposal puts in place
data collection obligations for the member states.

The link with the European Insolvency Regulation

Changing the EU insolvency landscape started with the
revision of the Insolvency Regulation (Regulation (EU)
848/2015) establishing rules on jurisdiction, applicable law
and recognition of cross-border insolvency procedures. The
Regulation will enable the recognition of preventive
restructuring procedures, however it makes no provision for
harmonising the substantive requirements under such procedures.
The Regulation will also enlarge the coverage of personal
insolvency procedures leading to a discharge of debt, but does
not establish any benchmarks in terms of length of the
discharge period. Finally, the Regulation will provide for
cooperation and communication in cross-border cases and will
interconnect national insolvency registers, thus making a first
step towards the digitalisation of insolvency procedures.

The Regulation will enter into force on June 26 2017.

What next

The Commission's proposal on preventive restructuring and
second chance is likely to bring more coherence among member
states' insolvency frameworks, thus improving legal certainty
for investors and facilitating the cross-border flow of
capital. Businesses will have better tools to address their
financial difficulties in times of crisis early on and as a
result, the ratio of restructurings to liquidations will
increase and more jobs will be saved. At the same time, the
rules will help prevent the accumulation of non-performing
loans and make the overall insolvency procedures more
efficient, thus cutting costs and time spent in proceedings and
increasing the recovery rate for creditors.

The European Parliament and the Council are now examining
the Commission's proposal, which is likely to enter into force
two years from the moment an agreement is reached and the
Directive is adopted by the co-legislators.

About the
author

Mihaela Carpus-Carcea

Mihaela Carpus-Carcea joined the European Commission
in 2009 and has worked in the Directorate-General for
Justice and Consumers as a legislative officer since
2010. Among the legislative projects in her
responsibility were the 2014 Commission recommendation
on a new approach to business failure and insolvency
and the 2016 Commission proposal for a directive on
preventive restructuring procedures and second chance.
Before joining the Commission, Carpus-Carcea worked in
private practice and in academia. She has a PhD in
European Union law from the University of
Birmingham.